This article is a section from a report “Investing in Nigeria” and shall be viewed in the context of the title. Please view the report for more information on the subject as well as references for this article.
Nigeria specific conditions
Africa’s industries and businesses differ from the developed world and the common industry growth patterns in these countries. An example is the informal sector – a lot of business is done informally and an industry eventually enters the formal stage as it grows, this was seen in the Nigerian lottery sector.
It should be kept in mind that frontier market industries might not fit well with the industry analysis frameworks used in the developed world. The due-diligence done in Nigeria is no different than that done in the developed countries in terms of what investors look for, it’s just that it’s way harder to find the information and data desired.
Some foreigner multinational manufacturers have invested in plants that have overcapacity. This works great for building entry barriers, as economies of scale can be achieved if needed and prices dumped to protect the market. It also appears that many companies are investing in the future potential of Nigeria, preparing for the mythical African middle class, with the building of overcapacity. Investors seem to follow a similar mind-set – Nestlé stock traded at 44 price earnings ratio at one point.
Businesses in the same industry don’t particularly compete against each other, but rather for the disposable incomes of Nigerians. Innovation in Nigeria means bringing existing products, technology and concepts, that have been around in the developed world for a while and introducing them in Nigeria. This puts a lot of emphasis on a good marketing strategy for successful businesses.
There is so much growth possible, especially in the unsaturated industries, that a businessmen in Africa can be successful simply by having pure focus on his business and sticking with it for a long time. Businesses don’t compete on day to day bases, a business doesn’t particularly need the best quality product or service – it simply needs a focus and work to be put in on the business.
The pure focus many successful businessmen in Nigeria have is reflected in the quality of goods. There have been records of domestic companies failing to enter markets abroad due to low quality or violations of consumer rights, such as best before dates.
Many of the world’s frontier markets are very similar in their economic appeal, but they differ in their operations and culture. Some opportunities in the economy might simply not be realizable by specific foreigner companies. Some argue that a partnership is more valuable than a business strategy. A business in Nigeria is likely to fail because of lack of contacts and operational know how rather than a lack of strategy.
Nigeria’s businesses are very volatile to new policies and regulations, these policies can evolve industries and companies. As concluded before – investors should view investments based on increased positive market conditions due to government policies as higher risk than the investments that are based on the opportunities in the markets now.
There are, however, government organizations set up that don’t fall under this risk category, since they are set up purely to increase market conditions by governments intervention. An example is the Agriculture Transformation Agenda (ATA) – an organization set up to develop the agriculture industry. ATA doesn’t have to win the elections every 4 years or constantly look for political allies. It can do its job and the people running it are accountable by the progress they have made. This results in actual actions being taken to positively increase the market conditions, lowering the risks.
One of the key elements in evaluating a company in Nigeria is to evaluate the entrepreneurs in terms of how structured they are and if they will follow proper corporate governance. Investment strategy adjustments should be made based on the willingness of the entrepreneurs in a company to be structured. A majority paper stakeholder might find it very challenging to exercise his majority with an unstructured company, so a minority stake is favoured in such a case.
The dependence on managers for the company’s success shall be looked at. The risks of companies that depend on one or two employees should be recognized – it’s not unseen for managers to leave a company to start their own shop. Equity shall be given to the key managers or the successful running of the business should be spread around to multiple people.
The lack of operating talent shall be accounted for. Some industries are more desired by employees than others – it should be evaluated how appealing a company is to potential employees. Investors can also look into the education levels the regions the company operates in has, to get an idea on how challenging it might be to find new employees.
A big interest rate for a company doesn’t particularly mean that it’s viewed as risky by the lender. A firm will pay high interest rate to compete versus the two digit percent returning federal bonds, not particularly because there is a high risk of default. The Bank of Industry offers one digit interest rates to some critical businesses. It should be seen if the company in question can qualify for this interest rate and if other firms in the industry are. In a company’s debt structure, the currencies the debt is in is the key information.
Good and efficient operations in a market like Nigeria’s are very important. A smaller company that is a part of an industry wide organization will get access to the latest trends and operational secrets. This is especially true if the industry has a big, multi industry player operating in it, as companies like Dangote Group are known to invest in training and upskilling their employees. It’s common for employees of different companies to exchange tips in industry gatherings, this was told by Aliko Dangote himself in an interview with OBG.
There are tax breaks for specific companies and an investor will likely be told if the company qualifies for any tax breaks. If there are no mentions of tax breaks, it is advised to check if other companies in the industry are qualified for tax breaks, as this might reveal insights on where the company in question stands in its industry.
A business plans success is often dependent on the whole value chain and one of the most important elements in the chain is the infrastructure across all participants of the chain. A farm that has a great yield will see it go to waste if there is no infrastructure to transport the agricultural outputs by.
To evaluate if the returns a firm is seeing are sustainable, the key infrastructural elements need to be identified and the development of these elements researched. It needs to be recognized how much the business can grow on the current level of infrastructure to determinate if the peak growth the infrastructure offers is achieved.
Companies need to be evaluated in terms of their competitiveness internationally. There are 150 Indian companies operating in Nigeria and even though the government has protectionist policies, these policies are likely not to be held for very long. There is a free trade deal in making with India. The EU and West Africa trade is strong and there are free trade deals proposed. It should be recognized if a business will face threats in case of a more free market conditions and how competitive the business will be. An alternative to a Nigerian business being competitive is great liquidity for the investment.
The fundamentals for companies are a lot different on ground versus the paper. There have been instances of foreigners buying companies thinking they can’t go wrong with the deals. Once they arrive to develop these companies, they find a completely unfit asset for its purpose that requires a lot more capital to get it to the condition they thought they were buying it in. The causes for such situation are rationalization, deregulation and privatization. This is yet another example that demonstrates the need for reliable local partners.
A company that sees cost savings from positive developments in the infrastructure it uses, won’t particularly see increases in its profits. The company can now grow further and the savings will go towards growing the business.